Job creation by the government – slight of hand

Much is made in the news and public pronouncements lately about how federal (or state) policies and programs are designed to create jobs. The stimulus program was supposed to create jobs. Lets think through the the issues to see if it seems possible that the federal government can create a net increase in jobs by moving money from one set of activities to another.

I’ll make up an example to illustrate the issues. Say the government wants to create jobs in roofing and gives a tax credit to those who buy a new roof. That will make roofs cheaper for those buying them, which will raise the demand for roofs. Assuming the supply of roofers is elastic then more demand for roofs will increase the employment of roofers. Thus it looks like the government tax credit did its job. However, to really answer that question we have to look at the entire effect of the tax credit, not just at its specifically intended effect. Where did that money come from? Taxpayers – either right away or eventually as they have to pay off the federal debt. One way or another it has to come out of tax payers pockets. (The federal government could just print more money but that still costs tax payers ultimately – a subject for a blog post another day.) That means the government took money out of everyone’s pocket to pay for the tax credit for roofers. Everyone now has a little less money to spend somewhere else. The money that was spent on roofs cannot also be spent on something else – we all get to spend our money just once. Given we are now spending less money than before in other areas of the economy then employment has to FALL in every other sector of the economy except roofing. It has to, there is no getting around it.

Now if employment fell in the rest of the economy less than it rose in roofing then there would still be a net gain in employment. Is that possible? The only way it could be possible is if the government somehow knew better than the market how to effectively use all our resources. If that were true then centrally planned economies would out-perform free market economies. We have ample evidence that that is not the case.

Thus any federal plan to spend money to increase employment in some specific sector is bound to fail when measured against the total employment level. The federal government has a proper role but creating jobs is not it. Leave that to the free market.

Here is another way to think about the issue – it is equally valid but a bit harder for me to express in convincing words. When people spend money freely, that is they are not coerced to spend money via tax, then they choose to spend money in areas that maximize their personal utility. Money is scarce for most of us so we try to get the most from it. If the government takes some of our money and spends it elsewhere and we have no control over how it is spent then it is impossible for the government to achieve the same maximized utility for any one of us. If they cannot do it for any individual then as a nation as a whole they cannot do it either. Thus any federal spending reduces total utility.

Prior to the tax incentive, the only roofers employed over the long term were those that could be employed profitably by the roofing company. If a company could make more profit (or for that matter more of whatever the owners wanted to make – even leisure time) by hiring an additional worker then they would do it. Thus with the addition of tax incentives, the roofing industry as a whole will hire more workers than is economically efficient. They have already chosen an efficient level of employment, adding tax dollars cannot move them to a more efficient level of funding.

“Creating jobs” as a rationale for tax policy is rarely ever an efficient approach – every tax dollar spent on one thing is one less dollar that could be spent by the tax payer on something else. Thus an increase in economic activity in the advantaged sector is completely offset by a decrease in economic activity everywhere else. When talking about federal initiatives to ‘create jobs’ politicians talk as if their spending creates economic activity that would not have been created otherwise. However the money they are spending doesn’t grow on trees, it comes out of someone’s pocket. The cumulative spending decisions of the whole populace are much more likely to allocate that money efficiently than is a small group of decision makers in Washington D.C.